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3 Reasons to Sell SandRidge Energy

I recently reminded investors of the bull case for SandRidge Energy (NYSE: SD) . As important as it is to know why you own a stock, I feel it's even more important to know what can go wrong. Given SandRidge's history, it's wise to be extra vigilant with this company.

SandRidge is a company that many market participants really hate. It doesn't help that shares are down nearly 90% over the past five years. That lackluster performance is one of the many reasons why many investors are convinced that there's more downside to come and at last count nearly 15% of its shares were sold short. Let's drill down into the three reasons why SandRidge might not be worth owning.

1. SandRidge has been dependent on selling assets to reduce its outsized debt position and fund its exploration budget.

The recent sale of its Permian Basin assets really helped the company to solidify its balance sheet. The deal enabled it to cut its leverage ratio in half to just two times. Further, it provided the necessary funding to see the company's capital program through the end of next year. Unfortunately, the sale was not without great cost as the Permian assets were oil levered cash flowing assets. However, SandRidge believes that it will received greater value by reinvesting those funds into its Mississippian acreage.

The problem here is that SandRidge has been dependent on asset sales and its running out of assets to sell. In addition to the Permian sale, SandRidge has now taken three royalty trusts public. One consisting of Permian Basin assets, SandRidge Permian Trust (NYSE: PER) and two consisting of Mississippian assets, SandRidge Mississippian Trust I (NYSE: SDT) and SandRidge Mississippian Trust II (NYSE: SDR) . While SandRidge still owns a portion of each trust, it likely will continue to sell off its ownership stake in each trust as well as other assets it still owns. At some point SandRidge will need to live within its oil and gas cash flows, otherwise, its not worth owning.

2. SandRidge has a risk-seeking management team with a history of overextending the company's resources, leading to a number of serious financial constraints.

Since taking the company public in 2007, SandRidge has lost about 90% of its value. Over that time frame CEO Tom Ward has pulled in $116 million in compensation. This hasn't sat well with investors, which is one reason why the newly expanded board has set a June 30 deadline to determine his fate.

During Ward's tenure, SandRidge's business plan has been in a constant state of transition. That's cost a lot of money and over the past two years Ward and his team have loaded the company with nearly $4 billion in net debt and taken its leverage ratio to as high as 4.6 times. The good news is that the recent Permian Basin sale has taken that debt down to a net of less than one and a half billion and a leverage ratio of just two times. However, until management demonstrates that it knows what its doing, the risk is that its spending could get it into trouble again.

3. The Mississippian doesn't appear to be as oily as the company originally thought with a production mix that is 45% oil and natural gas liquids and 55% natural gas.

At the company's 2011 analyst day, Sandridge's Mississippian liquids content was at 52% of production. However, as it has continued to drill, that liquids content has slipped to 45% of production. That's a bit lower than Chesapeake Energy (NYSE: CHK) is seeing; its fourth-quarter Mississippian production was 54% liquids. The overall liquids production mix of the Mississippian is a lot less than Chesapeake is seeing in the Eagle Ford Shale, where its fourth-quarter production was 81% liquids. With natural gas prices still on the low end, this lower liquids content from the Mississippian is not good for SandRidge's cash flow.

SandRidge continues to appraise its acreage so it's possible that its liquids production could increase as its better able to determine the most profitable drilling locations. That's important because 80% of the company's Mississippian cash flow comes from oil production. However, if it finds that gas is more prevalent, it could take the company even longer to become cash flow positive.

Overall, none of these reasons appear that they'll doom the stock. With the company focusing on growing liquids production, the future actually looks optimistic. If you are unsure about the future of this emerging oil and gas junior and are looking to find out more about its strengths and weaknesses, then check out The Motley Fool's premium research report detailing SandRidge's game plan and what to expect from the company going forward. To get started, simply click here now!

Motley Fool contributor Matt DiLallo has no position in any stocks mentioned. The Motley Fool owns shares of SandRidge Mississippian Tr II and has the following options: Long Jan 2014 $20 Calls on Chesapeake Energy, Long Jan 2014 $30 Calls on Chesapeake Energy, and Short Jan 2014 $15 Puts on Chesapeake Energy. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Remember that nat gas fell over 75% since Tom Ward took his company public. He bought into land based oil right before the BP blow up in the gulf. He bought in to the gulf at fire sale price. Has he lost money on the Permian properties or the Miss. Trust assets. Does he still have a million acres of drilling left. The short position is easy to explain, with a 18% yield you buy the stock and you hedge with a put sell. If you ask me Tom Ward only mistake is being brilliant and wanting to to paid for it. You say his return has been bad, he had to buy time as nat gas prices tumbled off the table and he needed money to switch to oil. What would Einstein do take SD public and take the heat as your stock free falls. The proceeds give him money and time. That's why he isn't broke and out of business.

Give me a break! Tom Ward went all in on "low cost conventional ng" because he was a shale skeptic which he made pretty clear from early on. He was wrong and investors paid the price.

It is true that the shift to oil likely saved the company from BK but if not for much higher oil prices he still would have likely failed. I'd also point out that his hedging policies have led to tens of millions in lost income from being completely unhedged ng over the last year or two while having most oil production hedged over the last several years at prices below market.

Brilliant maybe, but he hasn't earned a dime for anyone but himself and a few lucky traders.

@B - As far as I can tell you were. The only thing I can figure is that the company is lumping its infrastructure investments (salt water disposal and electric) into the drilling number which is making it artificially higher. Everything they say points to them getting better so It doesn't make sense.

I'm afraid not, when SD talked about well costs back when they were claiming 2.7 to drill in Nov 2010 it included capex for SWD.

No, I'm afraid it's simply a matter of Tom allowing expenses to run up (which he claimed wouldn't happen) and then attempting to pat himself off the back for lowering them.

Doesn't really matter I guess.

FYI I went long today, despite my reservations, because I'm betting, if they haven't already, $4.40 gas will lead them to put significant ng hedges on for the next 6 months to a year. A buck move in ng prices is supposed to increase the ROR on a Mississippian well by 10% and they pretty much just got a $1.50 move in this quarter. Even their WTO wells are economic (barely) at this price.

We'll see if I'm right and also find out if the gunslinger is still running the show or if a little discipline is indeed being asserted.

Sending report...

Matthew is a Senior Energy and Materials Specialist with The Motley Fool. He graduated from the Liberty University with a degree in Biblical Studies and a Masters of Business Administration. You can follow him on Twitter for the latest news and analysis of the energy and materials industries: Follow @matthewdilallo